Yields tumble as RBI turns accommodative—what should fixed income investors do now?

The Reserve Bank of India’s recent 25 bps repo rate cut, the second time in a row, to 6% marks a clear pivot in its monetary policy stance, as it shifts from neutral to an accommodative posture. The central bank’s focus is now increasingly tilted towards supporting growth amid global uncertainties and a decisively benign inflation outlook. This shift unlocks a fresh set of opportunities for fixed-income investors,particularly in medium to longer-duration bonds and tax-efficient avenues like tax-free PSU bonds.

Market Reaction: Bond Yields Slide as Easing Cycle Begins

The bond market has welcomed the rate cut and dovish policy guidance. The benchmark 10-year government bond has seen a sharp rally, with the semi-annual yield dropping to around 6.35%, and briefly dipping as low as 6.30%, a level not seen since 2021. The rally reflects growing market confidence that the RBI has entered a sustained easing cycle.

Traders and institutional investors are now pricing in another 50–75 basis points of rate cuts over the next 12 months, driven by the improving inflation trajectory and a weaker global growth outlook.

In the short-term market, T-bills and CPs have seen yields soften by 10–25 basis points, especially in the 91-day to 6-month segment. This moderation is consistent with the RBI’s efforts to improve monetary transmission and maintain orderly market conditions through liquidity operations.

Liquidity Infusion: Aiding Transmission

The RBI’s liquidity operations have also played a supportive role in this rate rally. Over the past few months, the central bank has infused durable liquidity through variable rate repos and G-Sec purchases (OMOs). This has helped ease system liquidity, supported credit flow, and improved sentiment in money markets. The comfortable liquidity environment, coupled with an accommodative stance, is enabling a smoother transmission of the policy cut to market rates—a key objective of the RBI’s approach in this cycle.

What Should Fixed Income Investors Do?

This environment presents a compelling case for increasing duration selectively in bond portfolios. Long-dated sovereign and AAA-rated bonds in the 7–10 year segment look attractive, especially before yields compress further. Target maturity funds (TMFs) maturing around 2030–2034 are also well-placed to lock in current levels and ride the easing cycle.

For those preferring more stability, short-to-medium-term SDL and AAA corporate bonds, offer a decent spread over G-Secs while managing duration risk. Investors with tactical flexibility may consider dynamic bond funds, which are well-positioned to benefit from falling yields and credit spread compression.

Tax-Free Bonds: Quietly Regaining Appeal

In this backdrop, tax-free bonds—though not newly issued—are quietly gaining traction in the secondary market. PSU issuers like NHAI, IRFC, and PFC offer YTMs in the range of 5.20%-5.40%, which translates to a pre-tax equivalent of 8.00%-8.50% for those in the 30%+ tax bracket.

Compared to fixed deposits, government bonds (~6.3%), or AAA corporate bonds (~7.3%), tax-free bonds deliver significant post-tax alpha, with minimal credit risk and predictable cash flows. Ideal for retirees, HNIs, or conservative long-term investors, these instruments are particularly attractive in a falling rate environment, where traditional savings avenues may deliver diminishing returns.

Conclusion: Policy Pivot in Play – Time to Lock In

With the RBI clearly entering an easing cycle, supported by disinflation and proactive liquidity management, the macro backdrop for fixed income looks stronger than it has in years. Yields on long-dated G-Secs have already begun to reflect this, but further room for compression exists, especially if the expected 50–75 bps of cuts materialise over the next year.

The April MPC minutes reinforce this direction, with MPC members noting that “the time has now come for changing the stance to ‘accommodative’ from ‘neutral’” and that “monetary policy needs to nurture domestic demand impulses to further increase the growth momentum.” These statements indicate a clear willingness to act further, should the growth-inflation dynamics warrant it.

Against this backdrop, investors should consider extending portfolio duration, rebalancing towards high-quality credits, and allocating selectively to tax-efficient instruments. With real rates attractive and policy support visible, this may well be the ideal window to lock in long-term value in fixed income.

(The author is CIO – Fixed income, LGT Wealth India)

Disclaimer: This story is for educational purposes only. The views and recommendations made above are those of individual analysts or broking companies, and not of Mint. We advise investors to check with certified experts before making any investment decisions.